Bookkeeping All-In-One For Dummies

By Consumer Dummies

Your one-stop guide to mastering the art of bookkeeping

Do you need to get up and running on bookkeeping basics and the latest tools and technology used in the field? You've come to the right place! Bookkeeping All-In-One For Dummies is your go-to guide for all things bookkeeping, covering everything from learning to keep track of transactions, unraveling up-to-date tax information recognizing your assets, and wrapping up your quarter or your year. Bringing you accessible information on the new technologies and programs that develop with the art of bookkeeping, it cuts through confusing jargon and gives you friendly instruction you can put to use right away.

• Covers all of the new techniques and programs in the bookkeeping field
• Shows you how to manage assets and liabilities
• Explains how to track business transactions accurately with ledgers and journals
• Helps you make sense of accounting and bookkeeping basics

If you're just starting out in bookkeeping or an experienced bookkeeper looking to brush up on your skills, Bookkeeping All-In-One For Dummies is the only resource you'll need.

• Language: English
• Publisher: Wiley
• Release date: Aug 13, 2015
• ISBN: 9781119093954

Book preview

Introduction

Welcome to Bookkeeping All-In-One For Dummies! This book is a compendium of great Dummies content covering soup to nuts on bookkeeping with a good portion of accounting coverage as well.

The term bookkeeper may generate images of a mild-mannered person quietly, or even meekly, poring over columns of figures under a green banker’s lamp somewhere in a corner. In reality, the bookkeeper is vitally important and wields a tremendous amount of power within a company. Information tracked in the books helps business owners make key decisions involving sales planning and product offerings — and enables them to manage many other financial aspects of their business.

If it weren’t for the hard work of bookkeepers, companies wouldn’t have a clue about what happens with their financial transactions. Without accurate financial accounting, a company owner wouldn’t know how many sales were made, how much cash was collected, or how much cash was paid for the products sold to customers during the year. He or she also wouldn’t know how much cash was paid to employees or how much cash was spent on other business needs throughout the year. In other words, yes, clueless.

The creation and maintenance of financial records is also important, especially to those who work with the business, such as investors, financial institutions, and employees. People both inside (managers, owners, and employees) and outside the business (investors, lenders, and government agencies) all depend on the bookkeeper’s accurate recording of financial transactions.

Bookkeepers must be detailed-oriented, enjoy working with numbers, and be meticulous about accurately entering those numbers in the books. They must be vigilant about keeping a paper trail and filing all needed backup information about the financial transactions entered into the books. And they must be knowledgeable about all aspects of money as it percolates through a business and how to organize and present that information so that it’s useful to everyone involved in the business, including outside interests and, yes, the IRS.

That’s where this book comes in.

About This Book

Within this book, you may note that some web addresses break across two lines of text. If you’re reading this book in print and want to visit one of these web pages, simply key in the web address exactly as it’s noted in the text, pretending as though the line break doesn’t exist. If you’re reading this as an e-book, you’ve got it easy – just tap the web address to be taken directly to the web page.

Some figures herein use QuickBooks Pro. Because it’s the most popular financial accounting software, some chapters show you some of its advanced features where appropriate.

Foolish Assumptions

The book makes some key assumptions about who you are and why you’ve picked up this book. Much of the book assumes you are:

A business owner or manager who wants to know the ins and outs of how to do the books and what’s contained in financial records. You have a good understanding of business and its terminology but little or no knowledge of bookkeeping and accounting.

A person who does bookkeeping or plans to do bookkeeping for a small business and needs to know more about how to set up and keep the books. You have some basic knowledge of business terminology but don’t know much about bookkeeping or accounting, or how to create and maintain financial records.

A staff person in a small business who’s just been asked to take over the company’s bookkeeping duties. You need to know more about how transactions are entered into the books, how to prove out transactions to be sure you’re making entries correctly and accurately, and how to prepare financial reports using the data you collect.

Icons Used in This Book

For Dummies books use little pictures called icons to flag certain chunks of text that either you shouldn’t want to miss or you’re free to skip. Here are the icons used in this book and what they mean:

tip Look to this icon for ideas on how to improve your bookkeeping processes and use the information in the books to manage your business.

remember This icon marks anything you would do well to recall about bookkeeping after you’re finished reading this book.

warning This icon points out any aspect of bookkeeping that comes with dangers or perils that may hurt the accuracy of your entries or the way in which you use your financial information in the future. I also use this icon to mark certain things that can get you into trouble with the government, your lenders, your vendors, your employees, or your investors.

technicalstuff This points out material that may be interesting if you really want to know a little more, but which isn’t crucial to understanding the concept at hand. You can safely skip material with this icon if you like.

example When you see this icon, you have the chance to put your new-found knowledge to use. Practice your bookkeeping skills with real-world questions and story problems.

Beyond the Book

In addition to the material in the print or e-book you’re reading right now, this book also comes with some access-anywhere goodies on the Web. Check out the free Cheat Sheet at www.dummies.com/cheatsheet/bookkeepingaio for some handy bite-sized bookkeeping info, including the three elements of bookkeeping that must be kept in balance, definitions of the balance sheet and income statement, and the differences between the four types of business structures.

This book includes some extras that wouldn’t fit between the covers, kind of like the Bonus Content on a DVD. Check out http://www.dummies.com/extras/bookkeepingaio to read articles on the most important accounts bookkeepers keep, ways to manage cash using your books, tips on reading financial reports, and signs that a company is in trouble.

Where to Go From Here

Feel free to start anywhere you like. You can use the table of contents or index to zoom in on any topic you’re particularly interested in.

If you need the basics or if you’re a little rusty and want to refresh your knowledge of bookkeeping, start with Book I. For the nuts and bolts of accounting and financial reports, drop into Book II. If you already know the basics and terminology of bookkeeping and are ready for some practical advice on day-to-day activities, you might start with Book III. If you’re heading toward the end of the year and need to start wrapping things up, check out Book IV. If you’re a manager, Book V was written with you in mind.

Wherever you begin, best of luck on your bookkeeping journey!

Book I

Keeping the Books

webextra Visit www.dummies.com for great Dummies content online.

In this book …

Learn the basics of bookkeeping, from keeping business records to managing daily finances

Explore the Chart of Accounts that keeps a business financially organized

Understand the ins and outs of the General Ledger and learn how to develop and post entries

Discover how to simplify the journal process through your computer

Control your records and protect your business’s cash in the process

Find the right accounting software for you and your business

Review the three key financial statements and understand the difference between profit and cash flow

Chapter 1

Basic Bookkeeping

In This Chapter

arrow Introducing bookkeeping

arrow Managing daily business finances

arrow Keeping business records

arrow Navigating the accounting cycle

arrow Choosing between cash-basis and accrual accounting

arrow Deciphering double-entry bookkeeping

This chapter provides an overview of a bookkeeper’s work. If you’re just starting a business, you may be your own bookkeeper for a while until you can afford to hire one, so think of this chapter as your to-do list.

All businesses need to keep track of their financial transactions — that’s why bookkeeping and bookkeepers are so important. Without accurate records, how can you tell whether your business is making a profit or taking a loss? This chapter also covers the key parts of bookkeeping by introducing you to the language of bookkeeping, familiarizing you with how bookkeepers manage the accounting cycle, and showing you how to understand the most difficult type of bookkeeping — double-entry bookkeeping.

Bookkeeping, the methodical way in which businesses track their financial transactions, is rooted in accounting. Accounting is the total structure of records and procedures used to record, classify, and report information about a business’s financial transactions. Bookkeeping involves the recording of that financial information into the accounting system while maintaining adherence to solid accounting principles.

Bookkeepers: The Record Keepers of the Business World

Bookkeepers are the ones who toil day in and day out to ensure that transactions are accurately recorded. Bookkeepers need to be very detail oriented and love to work with numbers because numbers and the accounts they go into are just about all these people see all day. A bookkeeper is not required to be a certified public accountant (CPA).

Many small business people who are just starting up their businesses initially serve as their own bookkeepers until the business is large enough to hire someone dedicated to keeping the books. Few small businesses have accountants on staff to check the books and prepare official financial reports; instead, they have bookkeepers on staff who serve as the outside accountants’ eyes and ears. Most businesses do seek an accountant with a CPA certification.

In many small businesses today, a bookkeeper enters the business transactions on a daily basis while working inside the company. At the end of each month or quarter, the bookkeeper sends summary reports to the accountant who then checks the transactions for accuracy and prepares financial statements.

In most cases, the accounting system is initially set up with the help of an accountant in order to be sure it uses solid accounting principles. That accountant periodically stops by the office and reviews the system to be sure transactions are being handled properly.

warning Accurate financial reports are the only way you can know how your business is doing. These reports are developed using the information you, as the bookkeeper, enter into your accounting system. If that information isn’t accurate, your financial reports are meaningless. As the old adage goes, Garbage in, garbage out.

Delving into Bookkeeping Basics

If you don’t carefully plan your bookkeeping operation and figure out exactly how and what financial detail you want to track, you’ll have absolutely no way to measure the success (or failure, unfortunately) of your business efforts.

Bookkeeping, when done properly, gives you an excellent gauge of how well you’re doing financially. It also provides you with lots of information throughout the year so you can test the financial success of your business strategies and make course corrections early in the year if necessary to ensure that you reach your year-end profit goals.

tip Bookkeeping can become your best friend for managing your financial assets and testing your business strategies, so don’t shortchange it. Take the time to develop your bookkeeping system with your accountant before you even open your business’s doors and make your first sale.

Picking your accounting method: Cash basis versus accrual

You can’t keep books unless you know how you want to go about doing so. The two basic accounting methods you have to choose from are cash-basis accounting and accrual accounting. The key difference between these two accounting methods is the point at which you record sales and purchases in your books. If you choose cash-basis accounting, you only record transactions when cash changes hands. If you use accrual accounting, you record a transaction when it’s completed, even if cash doesn’t change hands.

For example, suppose your company buys products to sell from a vendor but doesn’t actually pay for those products for 30 days. If you’re using cash-basis accounting, you don’t record the purchase until you actually lay out the cash to the vendor. If you’re using accrual accounting, you record the purchase when you receive the products, and you also record the future debt in an account called Accounts Payable.

Understanding assets, liabilities, and equity

Every business has three key financial parts that must be kept in balance: assets, liabilities, and equity. Assets include everything the company owns, such as cash, inventory, buildings, equipment, and vehicles. Liabilities include everything the company owes to others, such as vendor bills, credit card balances, and bank loans. Equity includes the claims owners have on the assets based on their portion of ownership in the company.

The formula for keeping your books in balance involves these three elements:

Assets = Liabilities + Equity

Much of bookkeeping involves keeping your books in balance.

Introducing debits and credits

To keep the books, you need to revise your thinking about two common financial terms: debits and credits. Most nonbookkeepers and nonaccountants think of debits as subtractions from their bank accounts. The opposite is true with credits — people usually see these as additions to their accounts, in most cases in the form of refunds or corrections in favor of the account holders.

Well, forget all you thought you knew about debits and credits. Debits and credits are totally different animals in the world of bookkeeping. Because keeping the books involves a method called double-entry bookkeeping, you have to make at least two entries — a debit and a credit — into your bookkeeping system for every transaction. Whether that debit or credit adds or subtracts from an account depends solely upon the type of account.

Don’t worry. All this debit, credit, and double-entry stuff may sound confusing, but it will become much clearer as you work through this chapter.

Charting your bookkeeping course

You can’t just enter transactions in the books willy-nilly. You need to know where exactly those transactions fit into the larger bookkeeping system. That’s where your Chart of Accounts comes in; it’s essentially a list of all the accounts your business has and what types of transactions go into each one. Book I Chapter 2 talks more about the Chart of Accounts.

Recognizing the Importance of an Accurate Paper Trail

Keeping the books is all about creating an accurate paper trail. You want to track all of your company’s financial transactions so if a question comes up at a later date, you can turn to the books to figure out what went wrong.

remember An accurate paper trail is the only way to track your financial successes and review your financial failures, a task that’s vitally important in order to grow your business. You need to know what works successfully so you can repeat it in the future and build on your success. On the other hand, you need to know what failed so you can correct it and avoid making the same mistake again.

All your business’s financial transactions are summarized in the General Ledger, and journals keep track of the tiniest details of each transaction. You can make your information gathering more effective by using a computerized accounting system, which gives you access to your financial information in many different formats. Controlling who enters this financial information into your books and who can access it afterwards is smart business and involves critical planning on your part.

Maintaining a ledger

The granddaddy of your bookkeeping system is the General Ledger. In this ledger, you keep a summary of all your accounts and the financial activities that took place involving those accounts throughout the year.

You draw upon the General Ledger’s account summaries to develop your financial reports on a monthly, quarterly, or annual basis. You can also use these account summaries to develop internal reports that help you make key business decisions. Book I Chapter 3 talks more about developing and maintaining the General Ledger.

Keeping journals

Small companies conduct hundreds, if not thousands, of transactions each year. If every transaction were kept in the General Ledger, that record would become unwieldy and difficult to use. Instead, most companies keep a series of journals that detail activity in their most active accounts.

For example, almost every company has a Cash Receipts Journal in which to keep the detail for all incoming cash and a Cash Disbursements Journal in which to keep the detail for all outgoing cash. Other journals can detail sales, purchases, customer accounts, vendor accounts, and any other key accounts that see significant activity.

You decide which accounts you want to create journals for based on your business operation and your need for information about key financial transactions. Book I Chapter 4 talks more about journals and the accounts commonly journalized.

Instituting internal controls

Every business owner needs to be concerned with keeping tight controls on company cash and how it’s used. One way to institute this control is by placing internal restrictions on who has access to enter information into your books and who has access necessary to use that information.

You also need to carefully control who has the ability to accept cash receipts and who has the ability to disburse your business’s cash. Separating duties appropriately helps you protect your business’s assets from error, theft, and fraud. Book I Chapter 5 covers controlling your cash and protecting your financial records.

Computerizing

Most companies today use computerized accounting systems to keep their books. You should consider using one of these systems rather than trying to keep your books on paper. You’ll find your bookkeeping takes less time and is probably more accurate with a computerized system.

tip In addition to increasing accuracy and cutting the time it takes to do your bookkeeping, computerized accounting also makes designing reports easier. These reports can then be used to help make business decisions. Your computerized accounting system stores detailed information about every transaction, so you can group that detail in any way that may assist your decision making. Book I Chapter 6 talks more about computerized accounting systems.

Using Bookkeeping’s Tools to Manage Daily Finances

After you set up your business’s books and put in place your internal controls, you’re ready to use the systems you established to manage the day-to-day operations of your business. You’ll quickly see how a well-designed bookkeeping system can make your job of managing your business’s finances much easier.

Maintaining inventory

If your company keeps inventory on hand or in warehouses, tracking the costs of the products you plan to sell is critical for managing your profit potential. If you see inventory costs trending upward, you may need to adjust your own prices in order to maintain your profit margin. You certainly don’t want to wait until the end of the year to find out how much your inventory cost you.

You also must keep careful watch on how much inventory you have on hand and how much was sold. Inventory can get damaged, discarded, or stolen, meaning that your physical inventory counts may differ from the counts you have in your books. Do a physical count periodically — at least monthly for most businesses and possibly daily for active retail stores.

In addition to watching for signs of theft or poor handling of inventory, make sure you have enough inventory on hand to satisfy your customers’ needs. Book III Chapter 1 discusses how to use your bookkeeping system to manage inventory.

Tracking sales

Everyone wants to know how well sales are doing. If you keep your books up-to-date and accurate, you can get those numbers very easily on a daily basis. You can also watch sales trends as often as you think necessary, whether that’s daily, weekly, or monthly.

Use the information collected by your bookkeeping system to monitor sales, review discounts offered to customers, and track the return of products. All three elements are critical to gauging the success of the sales of your products.

If you find you need to offer discounts more frequently in order to encourage sales, you may need to review your pricing, and you definitely need to research market conditions to determine the cause of this sales weakness. The cause may be new activities by an aggressive competitor or simply a slow market period. Either way, you need to understand the weakness and figure out how to maintain your profit goals in spite of any obstacles.

While sales tracking reveals an increase in the number of your products being returned, you need to research the issue and find the reason for the increase. Perhaps the quality of the product you’re selling is declining, and you need to find a new supplier. Whatever the reason, an increased number of product returns is usually a sign of a problem that needs to be researched and corrected.

Book III Chapter 2 goes over how to use the bookkeeping system for tracking sales, discounts, and returns.

Handling payroll

Payroll can be a huge nightmare for many companies. Payroll requires you to comply with a lot of government regulation and fill out a lot of government paperwork. You also have to worry about collecting payroll taxes and paying employer taxes. And if you pay employee benefits, you have yet another layer of record keeping to deal with. Book III Chapter 3 is about managing payroll and government requirements.

Running Tests for Accuracy

All the time it takes to track your transactions isn’t worth it if you don’t periodically test to be sure you’ve entered those transactions accurately. If the numbers you put into your bookkeeping system are garbage, the reports you develop from those numbers will be garbage as well.

Proving out your cash

The first step in testing out your books includes proving that your cash transactions are accurately recorded. This process involves checking a number of different transactions and elements, including the cash taken in on a daily basis by your cashiers and the accuracy of your checking account. Book IV Chapter 3 covers all the steps necessary to take to prove out your cash.

Testing your balance

After you prove out your cash, you can check that you’ve recorded everything else in your books just as precisely. Review the accounts for any glaring errors and then test whether or not they’re in balance by doing a trial balance. You can find out more about trial balances in Book IV Chapter 5.

Doing bookkeeping corrections

You may not find your books in balance the first time you do a trial balance, but don’t worry. It’s rare to find your books in balance on the first try. Book IV Chapter 6 explains common adjustments that may be needed as you prove out your books at the end of an accounting period. It also explains how to make the necessary corrections.

Finally Showing Off Your Financial Success

Proving out your books and ensuring they’re balanced means you finally get to show what your company has accomplished financially by developing reports to present to others. It’s almost like putting your business on a stage and taking a bow — well … at least you hope you’ve done well enough to take a bow.

If you’ve taken advantage of your bookkeeping information and reviewed and consulted it throughout the year, you should have a good idea of how well your business is doing. You also should have taken any course corrections to ensure that your end-of-the-year reports look great.

Preparing financial reports

Most businesses prepare at least two key financial reports, the balance sheet and the income statement, which it can show to company outsiders, including the financial institutions from which the company borrows money and the company’s investors.

remember The balance sheet is a snapshot of your business’s financial health as of a particular date. The balance sheet should show that your company’s assets are equal to the value of your liabilities and your equity. It’s called a balance sheet because it’s based on a balanced formula:

Assets = Liabilities + Equity

The income statement summarizes your company’s financial transactions for a particular time period, such as a month, quarter, or year. This financial statement starts with your revenues, subtracts the costs of goods sold, and then subtracts any expenses incurred in operating the business. The bottom line of the income statement shows how much profit your company made during the accounting period. If you haven’t done well, the income statement shows how much you’ve lost.

Book II Chapter 4 covers preparing a balance sheet, Book II Chapter 5 talks about developing an income statement.

Paying taxes

Most small businesses don’t have to pay taxes. Instead, their profits are reported on the personal tax returns of the company owners, whether that’s one person (a sole proprietorship) or two or more people (a partnership). Only companies that have incorporated — become a separate legal entity in which investors buy stock — must file and pay taxes. (Partnerships and LLCs do not pay taxes unless they filed a special form to be taxed as a corporation, but they do have to file information returns, which detail how much the company made and how much profit each owner earned plus any costs and expenses incurred.) Book V Chapter 4 covers how business structures are taxed, and Book II Chapter 3 goes into more detail on business structures.

Wading through Bookkeeping Lingo

Before you can take on bookkeeping and start keeping the books, the first things you must get a handle on are key accounting terms. This section contains a list of terms that all bookkeepers use on a daily basis. This is just an overview, to get you more familiar with the lingo. Rest assured, all of this is covered in lots more detail throughout the book.

Accounts for the balance sheet

Here are a few terms you’ll want to know:

Balance sheet: The financial statement that presents a snapshot of the company’s financial position (assets, liabilities, and equity) as of a particular date in time. It’s called a balance sheet because the things owned by the company (assets) must equal the claims against those assets (liabilities and equity).

On an ideal balance sheet, the total assets should equal the total liabilities plus the total equity. If your numbers fit this formula, the company’s books are in balance.

Assets: All the things a company owns in order to successfully run its business, such as cash, buildings, land, tools, equipment, vehicles, and furniture.

Liabilities: All the debts the company owes, such as bonds, loans, and unpaid bills.

Equity: All the money invested in the company by its owners. In a small business owned by one person or a group of people, the owner’s equity is shown in a Capital account. In a larger business that’s incorporated, owner’s equity is shown in shares of stock. Another key Equity account is Retained Earnings, which tracks all company profits that have been reinvested in the company rather than paid out to the company’s owners. Small, unincorporated businesses track money paid out to owners in a Drawing account, whereas incorporated businesses dole out money to owners by paying dividends (a portion of the company’s profits paid by share of common stock for the quarter or year).

Accounts for the income statement

Here are a few terms related to the income statement that you’ll want to know:

Income statement: The financial statement that presents a summary of the company’s financial activity over a certain period of time, such as a month, quarter, or year. The statement starts with Revenue earned, subtracts out the Costs of Goods Sold and the Expenses, and ends with the bottom line — Net Profit or Loss.

Revenue: All money collected in the process of selling the company’s goods and services. Some companies also collect revenue through other means, such as selling assets the business no longer needs or earning interest by offering short-term loans to employees or other businesses.

Costs of goods sold: All money spent to purchase or make the products or services a company plans to sell to its customers.

Expenses: All money spent to operate the company that’s not directly related to the sale of individual goods or services.

Other common terms

Some other common terms include the following:

Accounting period: The time for which financial information is being tracked. Most businesses track their financial results on a monthly basis, so each accounting period equals one month. Some businesses choose to do financial reports on a quarterly basis, so the accounting periods are three months. Other businesses only look at their results on a yearly basis, so their accounting periods are 12 months. Businesses that track their financial activities monthly usually also create quarterly and annual reports (a year-end summary of the company’s activities and financial results) based on the information they gather.

Accounts Receivable: The account used to track all customer sales that are made by store credit. Store credit refers not to credit-card sales but rather to sales for which the customer is given credit directly by the store and the store needs to collect payment from the customer at a later date.

Accounts Payable: The account used to track all outstanding bills from vendors, contractors, consultants, and any other companies or individuals from whom the company buys goods or services

Depreciation: An accounting method used to track the aging and use of assets. For example, if you own a car, you know that each year you use the car its value is reduced (unless you own one of those classic cars that goes up in value). Every major asset a business owns ages and eventually needs replacement, including buildings, factories, equipment, and other key assets.

General Ledger: Where all the company’s accounts are summarized. The General Ledger is the granddaddy of the bookkeeping system.

Interest: The money a company needs to pay if it borrows money from a bank or other company. For example, when you buy a car using a car loan, you must pay not only the amount you borrowed but also additional money, or interest, based on a percentage of the amount you borrowed.

Inventory: The account that tracks all products that will be sold to customers.

Journals: Where bookkeepers keep records (in chronological order) of daily company transactions. Each of the most active accounts, including cash, Accounts Payable, Accounts Receivable, has its own journal.

Payroll: The way a company pays its employees. Managing payroll is a key function of the bookkeeper and involves reporting many aspects of payroll to the government, including taxes to be paid on behalf of the employee, unemployment taxes, and workers’ compensation.

Trial balance: How you test to be sure the books are in balance before pulling together information for the financial reports and closing the books for the accounting period.

Pedaling through the Accounting Cycle

As a bookkeeper, you complete your work by completing the tasks of the accounting cycle. It’s called a cycle because the workflow is circular: entering transactions, controlling the transactions through the accounting cycle, closing the books at the end of the accounting period, and then starting the entire cycle again for the next accounting period.

The accounting cycle has eight basic steps, which you can see in Figure 1-1.

©John Wiley & Sons, Inc.

Figure 1-1: The accounting cycle.

Transactions: Financial transactions start the process. Transactions can include the sale or return of a product, the purchase of supplies for business activities, or any other financial activity that involves the exchange of the company’s assets, the establishment or payoff of a debt, or the deposit from or payout of money to the company’s owners. All sales and expenses are transactions that must be recorded. The basics of documenting business activities involve recording sales, purchases, and assets, taking on new debt, or paying off debt.

Journal entries: The transaction is listed in the appropriate journal, maintaining the journal’s chronological order of transactions. (The journal is also known as the book of original entry and is the first place a transaction is listed.)

Posting: The transactions are posted to the account that it impacts. These accounts are part of the General Ledger, where you can find a summary of all the business’s accounts.

Trial balance: At the end of the accounting period (which may be a month, quarter, or year depending on your business’s practices), you calculate a trial balance.

Worksheet: Unfortunately, many times your first calculation of the trial balance shows that the books aren’t in balance. If that’s the case, you look for errors and make corrections called adjustments, which are tracked on a worksheet. Adjustments are also made to account for the depreciation of assets and to adjust for one-time payments (such as insurance) that should be allocated on a monthly basis to more accurately match monthly expenses with monthly revenues. After you make and record adjustments, you take another trial balance to be sure the accounts are in balance.

Adjusting journal entries: Post any necessary corrections after the adjustments are made to the accounts. You don’t need to make adjusting entries until the trial balance process is completed and all needed corrections and adjustments have been identified.

Financial statements: You prepare the balance sheet and income statement using the corrected account balances.

Closing: You close the books for the revenue and expense accounts and begin the entire cycle again with zero balances in those accounts.

remember As a businessperson, you want to be able to gauge your profit or loss on month by month, quarter by quarter, and year by year bases. To do that, Revenue and Expense accounts must start with a zero balance at the beginning of each accounting period. In contrast, you carry over Asset, Liability, and Equity account balances from cycle to cycle because the business doesn’t start each cycle by getting rid of old assets and buying new assets, paying off and then taking on new debt, or paying out all claims to owners and then collecting the money again.

Tackling the Big Decision: Cash-basis or Accrual Accounting

Before starting to record transactions, you must decide whether to use cash-basis or accrual accounting. The crucial difference between these two processes is in how you record your cash transactions.

Waiting for funds with cash-basis accounting

With cash-basis accounting, you record all transactions in the books when cash actually changes hands, meaning when cash payment is received by the company from customers or paid out by the company for purchases or other services. Cash receipt or payment can be in the form of cash, check, credit card, electronic transfer, or other means used to pay for an item.

Cash-basis accounting can’t be used if a store sells products on store credit and bills the customer at a later date. There is no provision to record and track money due from customers at some time in the future in the cash-basis accounting method. That’s also true for purchases. With the cash-basis accounting method, the owner only records the purchase of supplies or goods that will later be sold when he actually pays cash. If he buys goods on credit to be paid later, he doesn’t record the transaction until the cash is actually paid out.

tip Depending on the size of your business, you may want to start out with cash-basis accounting. Many small businesses run by a sole proprietor or a small group of partners use cash-basis accounting because it’s easy. But as the business grows, the business owners find it necessary to switch to accrual accounting in order to more accurately track revenues and expenses.

warning Cash-basis accounting does a good job of tracking cash flow, but it does a poor job of matching revenues earned with money laid out for expenses. This deficiency is a problem particularly when, as it often happens, a company buys products in one month and sells those products in the next month. For example, you buy products in June with the intent to sell, and pay $1,000 cash. You don’t sell the products until July, and that’s when you receive cash for the sales. When you close the books at the end of June, you have to show the $1,000 expense with no revenue to offset it, meaning you have a loss that month. When you sell the products for $1,500 in July, you have a $1,500 profit. So, your monthly report for June shows a $1,000 loss, and your monthly report for July shows a $1,500 profit, when in actuality you had revenues of $500 over the two months.

For the most part, this book concentrates on the accrual accounting method. If you choose to use cash-basis accounting, don’t panic: You’ll still find most of the bookkeeping information here useful, but you don’t need to maintain some of the accounts, such as Accounts Receivable and Accounts Payable, because you aren’t recording transactions until cash actually changes hands. If you’re using a cash-basis accounting system and sell things on credit, though, you’d better have a way to track what people owe you.

Recording right away with accrual accounting

With accrual accounting, you record all transactions in the books when they occur, even if no cash changes hands. For example, if you sell on store credit, you record the transaction immediately and enter it into an Accounts Receivable account until you receive payment. If you buy goods on credit, you immediately enter the transaction into an Accounts Payable account until you pay out cash.

warning Like cash-basis accounting, accrual accounting has its drawbacks. It does a good job of matching revenues and expenses, but it does a poor job of tracking cash. Because you record revenue when the transaction occurs and not when you collect the cash, your income statement can look great even if you don’t have cash in the bank. For example, suppose you’re running a contracting company and completing jobs on a daily basis. You can record the revenue upon completion of the job even if you haven’t yet collected the cash. If your customers are slow to pay, you may end up with lots of revenue but little cash.

tip Many companies that use the accrual accounting method also monitor cash flow on a weekly basis to be sure they have enough cash on hand to operate the business. If your business is seasonal, such as a landscaping business with little to do during the winter months, you can establish short-term lines of credit through your bank to maintain cash flow through the lean times.

Seeing Double with Double-Entry Bookkeeping

All businesses, whether they use the cash-basis accounting method or the accrual accounting method, use double-entry bookkeeping to keep their books. A practice that helps minimize errors and increase the chance that your books balance, double-entry bookkeeping gets its name because you enter all transactions twice.

remember When it comes to double-entry bookkeeping, the key formula for the balance sheet (Assets = Liabilities + Equity) plays a major role.

In order to adjust the balance of accounts in the bookkeeping world, you use a combination of debits and credits. You may think of a debit as a subtraction because you’ve found that debits usually mean a decrease in your bank balance. On the other hand, you’ve probably been excited to find unexpected credits in your bank or credit card that mean more money has been added to the account in your favor. Now, forget all that you ever learned about debits or credits. In the world of bookkeeping, their meanings aren’t so simple.

The only definite thing when it comes to debits and credits in the bookkeeping world is that a debit is on the left side of a transaction and a credit is on the right side of a transaction. Everything beyond that can get very muddled. Don’t worry if you’re finding this concept very difficult to grasp. You get plenty of practice using these concepts throughout this book.

Before getting into all the technical mumbo jumbo of double-entry bookkeeping, here’s an example of the practice in action. Suppose you purchase a new desk that costs $1,500 for your office. This transaction actually has two parts: You spend an asset — cash — to buy another asset — furniture. So, you must adjust two accounts in your company’s books: the Cash account and the Furniture account. Here’s what the transaction looks like in a bookkeeping entry:

In this transaction, you record the accounts impacted by the transaction. The debit increases the value of the Furniture account, and the credit decreases the value of the Cash account. For this transaction, both accounts impacted are asset accounts, so, looking at how the balance sheet is affected, you can see that the only changes are to the asset side of the balance sheet equation:

Assets = Liabilities + Equity

Furniture increase = Cash decreases = No change to total assets

In this case, the books stay in balance because the exact dollar amount that increases the value of your Furniture account decreases the value of your Cash account. At the bottom of any journal entry, you should include a brief explanation that explains the purpose for the entry. The first example indicates this entry was To purchase a new desk for the office.

To show you how you record a transaction if it impacts both sides of the balance sheet equation, here’s an example that shows how to record the purchase of inventory. Suppose you purchase $5,000 worth of widgets on credit. (Haven’t you always wondered what widgets were? You won’t find the answer here. They’re just commonly used in accounting examples to represent something that’s purchased.) These new widgets add value to your Inventory Asset account and also add value to your Accounts Payable account. (Remember, the Accounts Payable account is a Liability account where you track bills that need to be paid at some point in the future.) Here’s how the bookkeeping transaction for your widget purchase looks:

Here’s how this transaction affects the balance sheet equation:

Assets = Liabilities + Equity

Inventory increases = Accounts Payable increases = No change

In this case, the books stay in balance because both sides of the equation increase by $5,000.

remember You can see from the two example transactions how double-entry bookkeeping helps to keep your books in balance — as long as you make sure each entry into the books is balanced. Balancing your entries may look simple here, but sometimes bookkeeping entries can get very complex when more than two accounts are impacted by the transaction. Don’t worry, you don’t have to understand it totally now. You’ll see how to enter transactions throughout the book. Again, this is just a quick overview to introduce the subject.

Differentiating Debits and Credits

Because bookkeeping’s debits and credits are different from the ones you’re used to encountering, you’re probably wondering how you’re supposed to know whether a debit or credit will increase or decrease an account. Believe it or not, identifying the difference will become second nature as you start making regular bookkeeping entries. But to make things easier, Table 1-1 is a chart that’s commonly used by all bookkeepers and accountants.

Table 1-1 How Credits and Debits Impact Your Accounts

tip Copy Table 1-1 and post it at your desk when you start keeping your own books. It will help you keep your debits and credits straight!

Chapter 2

Charting the Accounts

In This Chapter

arrow Introducing the Chart of Accounts

arrow Reviewing the types of accounts that make up the chart

arrow Creating your own Chart of Accounts

Can you imagine the mess your checkbook would be if you didn’t record each check you wrote? You’ve probably forgotten to record a check or two on occasion, but you certainly learn your lesson when you realize that an important payment bounces as a result. Yikes!

Keeping the books of a business can be a lot more difficult than maintaining a personal checkbook. Each business transaction must be carefully recorded to make sure it goes into the right account. This careful bookkeeping gives you an effective tool for figuring out how well the business is doing financially.

As a bookkeeper, you need a road map to help you determine where to record all those transactions. This road map is called the Chart of Accounts. This chapter tells you how to set up the Chart of Accounts, which includes many different accounts. It also reviews the types of transactions you enter into each type of account in order to track the key parts of any business: assets, liabilities, equity, revenue, and expenses.

Getting to Know the Chart of Accounts

The Chart of Accounts is the road map that a business creates to organize its financial transactions. After all, you can’t record a transaction until you know where to put it! Essentially, this chart is a list of all the accounts a business has, organized in a specific order; each account has a description that includes the type of account and the types of transactions that should be entered into that account. Every business creates its own Chart of Accounts based on how the business is operated, so you’re unlikely to find two businesses with the exact same Charts of Accounts.

However, some basic organizational and structural characteristics are common to all Charts of Accounts. The organization and structure are designed around two key financial reports: the balance sheet, which shows what your business owns and what it owes, and the income statement, which shows how much money your business took in from sales and how much money it spent to generate those sales. (You can find out more about balance sheets in Book II Chapter 4 and income statements in Book II Chapter 5.)

The Chart of Accounts starts with the balance sheet accounts, which include the following:

Current Assets: Includes all accounts that track things the company owns and expects to use in the next 12 months, such as cash, accounts receivable (money collected from customers), and inventory

Long-term Assets: Includes all accounts that track things the company owns that have a lifespan of more than 12 months, such as buildings, furniture, and equipment

Current Liabilities: Includes all accounts that track debts the company must pay over the next 12 months, such as accounts payable (bills from vendors, contractors, and consultants), interest payable, and credit cards payable

Long-term Liabilities: Includes all accounts that track debts the company must pay over a period of time longer than the next 12 months, such as mortgages payable and bonds payable

Equity: Includes all accounts that track the owners of the company and their claims against the company’s assets, which include any money invested in the company, any money taken out of the company, and any earnings that have been reinvested in the company

The rest of the chart is filled with income statement accounts, which include

Revenue: Includes all accounts that track sales of goods and services as well as revenue generated for the company by other means

Cost of Goods Sold: Includes all accounts that track the direct costs involved in selling the company’s goods or services

Expenses: Includes all accounts that track expenses related to running the business that aren’t directly tied to the sale of individual products or services

When developing the Chart of Accounts, you start by listing all the Asset accounts, the Liability accounts, the Equity accounts, the Revenue accounts, and finally, the Expense accounts. All these accounts come from two places: the balance sheet and the income statement.

tip This chapter reviews the key account types found in most businesses, but this list isn’t cast in stone. You should develop an account list that makes the most sense for how you operate your business and the financial information you want to track. As you explore the accounts that make up the Chart of Accounts, you’ll see how the structure may differ for different businesses.

remember The Chart of Accounts is a money management tool that helps you track your business transactions, so set it up in a way that provides you with the financial information you need to make smart business decisions. You’ll probably tweak the accounts in your chart annually and, if necessary, you may add accounts during the year if you find something for which you want more detailed tracking. You can add accounts during the year, but it’s best not to delete accounts until the end of a 12-month reporting period. Book IV Chapter 6 discusses adding and deleting accounts from your books.

Starting with the Balance Sheet Accounts

The first part of the Chart of Accounts is made up of balance sheet accounts, which break down into the following three categories:

Asset: These accounts are used to track what the business owns. Assets include cash on hand, furniture, buildings, vehicles, and so on.

Liability: These accounts track what the business owes, or, more specifically, claims that lenders have against the business’s assets. For example, mortgages on buildings and lines of credit are two common types of liabilities.

Equity: These accounts track what the owners put into the business and the claims owners have against assets. For example, stockholders are company owners that have claims against the business’s assets.

The balance sheet accounts, and the financial report they make up, are so-called because they have to balance out. The value of the assets must be equal to the claims made against those assets. (Remember, these claims are liabilities made by lenders and equity made by owners.)

Book II Chapter 4 discusses the balance sheet in greater detail, including how it’s prepared and used. This section, however, examines the basic components of the balance sheet, as reflected in the Chart of Accounts.

Tackling assets

First on the chart are always the accounts that track what the company owns — its assets: current assets and long-term assets.

Current assets

Current assets are the key assets that your business uses up during a 12-month period and will likely not be there the next year. The accounts that reflect current assets on the Chart of Accounts are as follows:

Cash in Checking: Any company’s primary account is the checking account used for operating activities. This is the account used to deposit revenues and pay expenses. Some companies have more than one operating account in this category; for example, a company with many divisions may have an operating account for each division.

Cash in Savings: This account is used for surplus cash. Any cash for which there is no immediate plan is deposited in an interest-earning savings account so that it can at least earn interest while the company decides what to do with it.

Cash on Hand: This account is used to track any cash kept at retail stores or in the office. In retail stores, cash must be kept in registers in order to provide change to customers. In the office, petty cash is often kept around for immediate cash needs that pop up from time to time. This account helps you keep track